The ripple effect

If the consulting “industry” is a collection of micro-markets, you’d expect any downturn to hit sectors and services at different times and with varying degrees of ferocity.  That would certainly be borne out by the experience of niche firms in recent years: 2002-04 saw some firms powering ahead while others gave up an unequal struggle.  Bigger firms see this, too, although their broader portfolio disguises the ups and downs of specific markets.

These slides attempt to show how a downturn rolls across the major sectors and services in consulting.

The first – the impact on sectors – is based on historic data (from the UK’s Management Consultancies Association covering the period 2002-04).  It breaks downturns up into three distinct phases.  The first is paralysis, when clients aren’t sure what’s going on and are reluctant to take any precipitous action, either cancelling existing projects or starting new ones.  Paralysis is followed by a period of re-focus as clients’ objectives shift: revenue generation projects turn into cost-cutting ones; talent management work shifts towards headcount reduction.  If the economic news continues to be bad, clients start to cut back their expenditure on consultants.  My guess is that we’re about one year in: we’re already seeing investment banks making sharp cuts in their consulting budgets and other sectors re-focusing.  The thing to watch, though, is that by the time heavy manufacturing starts to cut back its use of consultants, investment banks are starting to increase theirs.

The second slide – the impact on services – is based on a combination of historic data (again from the MCA) but this time overlaid with recent feedback from clients and consulting firms.  Again, we’re about a year in and just at a point where we might expect to see a serious cutback in expenditure on strategy (most clients say they will do this, although it will be interesting to see whether the financial crisis fuels the need for more, not less, strategy consulting in that sector).  Programme management is likely to come down quite sharply, partly because there will be fewer programmes to manage but also because clients will be more likely to hire freelance programme managers rather than expensive firms.  Operational consulting, focused on cost-cutting and performance improvement, is likely to do reasonably well, at least until a point where clients simply run out of money.

However, perhaps the key difference between this downturn and that of 2002 seems to be the role of IT expenditure.  This was one of the main casualties six years ago, a backlash to the high levels of investment around the Year 2000, the dotcom boom and the initial wave of ERP implementations.  The sentiment this time appears to be different: clients see technology as critical to making efficiency savings and want to protect their investment in this rather than cut it back.

How bad will it get?

The question on every consultants’ lips at the moment is just how badly will a recession affect their business.

The answer comes in three stages.

First, it’s increasingly hard these days to talk of a consulting “industry”.  What we have instead is really a series of micro industries, each with their own micro economic climates.  Looking back at the data for 2002, it’s clear that downturns in consulting start off in investment banks, then ripple through other areas of financial services.  No surprise there.  Cutbacks in consulting budgets then ripple through other sectors, starting off with those closest to consumer spending (retailing, then telecoms and consumer products) before moving on to the parts of the economy that supply products and services to those sectors already hit.  Ironically, by the time consulting expenditure among manufacturing is on the slide that in investment banks has started to come back.  Of course there are some sectors which stand aloof from this process, notably the public sector, where expenditure on consultants tends to increase as it decreases in the private sector.

These micro markets mean that the performance of niche firms will be wildly different, driven entirely by the sectors they focus on, but that bigger firms should be able to play the market, moving people from sectors where demand is shrinking to where it is growing.  However, the ability of firms to bend with the economic wind is not as great as it was – and this is my second point.  That’s primarily because client demand for specialist skills has been steadily increasing for the last decade and that makes consulting firms less flexible.  Consultants who are expert in a specific field are far less easy to deploy in other fields than the generalists of old.  Thus, in 2002 it was just about possible to take consultants out of financial services practices and put them into public sector ones, but it’s not today.  Consultants, like leopards, can’t change their spots.

They can, however, travel.  My third and final point is that some, lucky firms will be able to compensate for their increasingly rigid organisational model by taking advantage of the fact that consulting is a more global industry than it was ten years ago.  Large, global firms will be able to protect their margins by using resources from different countries where salaries are lower.  Niche firms will look to export their specialist skills to countries which are at a different point in their economic cycle.

What I infer from this is that effect of a downturn will be patchy.  Some niche firms will thrive while others go to the wall.  The largest firms, working in a balanced portfolio of sectors, will ultimately be able to weather the storm.  The chief casualties will be the mid-sized firms whose spread of sectors may not be wide enough to spread their risk and which are not sufficiently global to shift their people or business.

It’s clearly going to be a tough market, but it’s going to be ten times tougher if you’re caught in the middle ground.

Cycles and scenarios

Of course it’s dangerous to use the past as a guide to the future, but bear with me for a moment.

Looking back over the last 20 years, I increasingly think that the consulting industry works on five year cycles: three years or so of relatively high growth, followed by two years or so of lower growth.  Sometimes it’s boom followed by bust; sometimes the change is less dramatic.  Thus, the downturn of 1992-93 became the ERP-fuelled boom of the mid-1990s; the prospect of recession in 1997 slowed the growth rate in consulting only to be replaced by the dotcom bubble; the pricking of that bubble brought a serious contraction of the market in 2002-03, but that was reversed by the upswing of the last few years.

Some downturns (eg 1997) are mild – the growth rate falls back but it doesn’t go negative – but some (eg 2002) are far more severe.  What determines whether a downturn is mild or severe is a crucial question just now, and that comes down to two factors: timing and economic indicators.  In 1997, there was much talk of an imminent recession and growth in consulting consequently slowed.  But about one year in (that’s halfway through the downswing of my five year cycle), the economic news wasn’t as bad as expected: people came out of their bunkers and got back to business as usual.  In 2003, again halfway through the downswing, the news was remorselessly depressing, and that pushed clients into making serious cutbacks in their consulting budgets.

I’d say that this downturn started in the summer of last year.  Not every consulting firm felt it, but for many firms, the last third of the year was pretty flat.  However, business picked up at the start of 2008 and the gloomiest prognoses were put on hold.  But not for long: the market was looking uncertain over last summer – as one consultant put it to me: “Our clients have their foot hovering over the break; they just have started to press down yet.”  And what happened next?  The financial news got just about as bad as it could be and certainly far worse than many people had ever supposed was possible.  And unfortunately for consultants, the news got worse just at the crucial point when clients were weighing up whether this was a real downturn à la 2002-03 or a phoney one along the lines of 1997.  Well, now they know.  And now we know that it’s probably going to be pretty bad for consultants, at least up to the end of 2009.

But then, of course, the inevitable recovery will kick in.